Negative Interest Rates Explained in Five Graphs

Why did the European Central Bank cut rates and introduce a negative overnight deposit rate which will essentially charge European Banks for the privilege of avoiding risk and depositing cash with the European Central Bank? This is best explained through a series of graphics.

Devaluing the Euro:

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Driving down the value of the Euro is undoubtedly a motivating factor. Even after its recent slide, it is still 12 percent higher against the dollar than this time almost two years ago. The French government has been grumbling for a while now that a strong Euro has been harmful to some areas of the economy and the rise of the National Front and other ‘anti-EU’ parties will have given added impetus to staving off a decline in manufacturing and boosting the export potential of Europe.

Forcing banks to lend:

Private credit has been contracting as lending by banks to individuals has been declining for almost two years and the ECB is clearly desperate to avoid this becoming a deflationary spiral. Their hope will be that banks are forced in to lending out this money.

Reduce unemployment:

Unlike the Federal Reserve, the European Central Bank does not have a mandate to reduce unemployment. That said, to remain oblivious to the fact that unemployment hasn’t budged for two years, remaining stubbornly high at 11.7 percent (compared to 6.3 percent in the US and 6.8 percent in the UK), is a risky strategy in light of growing political unrest on the continent. Youth unemployment in the region of 25 percent also remains a concern.

Low inflation:

The risk for the European Central Bank is that in an environment of low inflation and low growth, people avoid take on the risk of borrowing money to make purchases which in turn makes businesses less likely to invest in increasing inventory. If that spirals down in to deflation, then there actually becomes an incentive to hold on to cash in anticipation of lower prices at a later date. Such an outcome could fatally paralyse the Eurozone economy.

Selling price expectations are at rock bottom:

Linked to inflation. If producers consistently anticipate getting a lower price for the goods or services they provide, there is little incentive for them to invest in capital and take on additional employees.